Wages and Unemployment

Dr. Russell is Director of the School of Politi­cal Economy of the Foundation for Economic Education.

You hear it everywhere: Wages must be kept high in order to in­crease the purchasing power of the wage earners, so that they can buy back the products they make in our factories, and thus keep everybody working and prevent depressions.

But in both theory and practice, that "high wage and spending" cliché confuses the issue in two ways. First, regardless of the di­vision of industrial income be­tween wage earners and dividend earners, that income will still be spent in one way or another for more goods and services. Thus, the issue is not "spending" as such, but rather who does the spending and for what. Second, it is capital investment (which is also "spending") that builds the factories and provides the jobs here under discussion.

Actually, when there is an in­crease in the percentage of total industrial income going for wages, there is also likely to be an in­crease in unemployment. Here is how it works: When a company has losses or earns comparatively small profits, a higher percentage of the income available for distri­bution obviously goes to employees rather than to owners. During such "red ink" recessions and de­pressions, the owners get little or nothing; the employees some­times get it all. Yet it is precisely during these loss-and-low-profit periods that unemployment is highest.

The Department of Commerce (Survey of Current Business series) will confirm the following: When the percentage of national income going to capital is higher than usual (that is, when indus­trial profits are above average), jobs are plentiful and unemploy­ment is comparatively low. That correlation between high profits and more jobs should be obvious to everyone, since you can easily deduce it from the fact that com­panies go broke and close down when there are losses or inadequate profits. But for some un­known reason, that direct and observable relationship between in­dustrial jobs and profits is usually denied by union leaders and gov­ernment officials.

Since 1930 and our govern­ment’s deliberate policy of main­taining wages above the free mar­ket level, peacetime unemployment has become our most persistent economic problem. And millions of American workers are still unem­ployed today, in spite of the high­est consumer purchasing power (and spending) in our history. Yet, for the most part, union leaders and lawmakers claim they will correct the situation by rais­ing wages at the expense of profits!

For the past 15 years in Ger­many (and several other nations), the percentage of national income going for wages has been much lower than in the United States. If the "high wage and consumer spending" theory of employment had any validity at all, it would necessarily follow that there would be more unemployment (percentage wise) in Germany today than in the United States. But the re­verse is true. In fact, there has been (and still is) a serious labor shortage in Germany, in spite of the influx of millions of persons from the occupied territories. But the current and increasing de­mands of the again-powerful Ger­man labor unions for "higher wages and more purchasing power" will doubtless soon change that surplus of jobs into a short­age.

All the "consumer purchasing power" in the world cannot create even one permanent job in an economy where the return on cap­ital is negligible or nothing. That is, if every person in the world had twice as much money as he now has to spend, not one job would thereby be created unless the owners of the factories be­lieved they could earn adequate profits. It is the actual and antici­pated return on capital, not con­sumer purchasing power as such, that causes investment in new buildings and machines, and the resulting creation of more produc­tion and more jobs. Thus, laws and coercive union policies that in­crease wages at the expense of profits do not create jobs; they destroy them.

Reprints of this article are available of 2 cents each, this being No. 37 in a series of 39 suggested answers to various "Cliches of Socialism." Complete list available on request.

THE FREEMAN

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December 2014

Unfortunately, educating people about phenomena that are counterintuitive, not-so-easy to remember, and suggest our individual lack of human control (for starters) can seem like an uphill battle in the war of ideas. So we sally forth into a kind of wilderness, an economic fairyland. We are myth busters in a world where people crave myths more than reality. Why do they so readily embrace untruth? Primarily because the immediate costs of doing so are so low and the psychic benefits are so high.